70% of the annual revenue collected by the IRS each year comes from payroll taxes. Misreported and unpaid employment taxes account for $72 million of the tax gap in the U.S.
For this reason, there are major consequences when a business fails to accurately pay payroll taxes, such as payroll debt.
As a business owner, you have a lot on your plate. The last thing you need to worry about is payroll tax penalties and falling into payroll debt because you made a mistake.
Keep reading to learn more about your payroll tax responsibilities and staying compliant with employment tax law.
Understanding Your Payroll Tax Responsibilities
As a business with employees, you have three key responsibilities as far as the IRS is concerned – collecting, reporting, and paying payroll taxes. If you make mistakes or fail to keep up these responsibilities, you could face penalties from the IRS for failure to pay payroll taxes.
If you miss the deposit deadlines, the IRS and other tax agencies will take note. Employers have to withhold taxes from their employee’s wages and also contribute taxes themselves.
Here are the main employment taxes you will be responsible for as an employer:
- Federal, state, and local income taxes
- FICA tax (Social Security and Medicare taxes)
- Federal and state unemployment taxes
- Taxes specific to your state
Most of these taxes should be withheld from employee wages by the employer. These include income taxes, Medicare and Social Security taxes, and applicable state-specific taxes. As an employer, you also have to contribute to FICA (Social Security and Medicare) taxes, unemployment taxes, and any applicable state-specific taxes.
Taxes that you are withholding and your tax contribution should be set aside and then deposited according to your depositing schedule. This schedule is usually either monthly or semiweekly. In some cases, it is annually.
Your schedule will be based on a four-quarter IRS lookback period. The federal unemployment tax is deposited on a quarterly basis. Your deposit schedule for state unemployment tax and other state-specific taxes vary depending on where you live.
To determine when to deposit these taxes, contact your state. Of course, you’ll need to report payroll taxes to the IRS and any other relevant tax agencies.
Reasons Companies Fail to Pay
There are many reasons employers forget to pay payroll taxes, some of them innocent and some not so much. Mistakes can happen to the best business owners.
For example, you might correctly withhold payroll taxes from your employee wages and set the money aside. Come time to make your deposit, you’re focused on something else and simply forget. If you miss your deposit due date, you’ll forget to pay the taxes entirely.
Or maybe you set aside the money but borrow from the account when you’re low on cash. Then when your deposit is due you don’t have the money to pay. Some business owners also experience situations like natural disasters that lead to missed deposits.
Sometimes deposit schedules change and employers accidentally miss deadlines. Whatever the case may be, failing to pay payroll taxes is never a good thing and you should do everything you can to avoid such a situation.
Common Payroll Compliance Mistakes
Staying compliant with payroll and labor laws is challenging for businesses of all sizes. Failing to follow the rules can cost your business. Some of the most common legal claims employees make against their employers involve payroll problems.
Let’s take a look at some of the most common payroll issues to avoid.
Paying Employees Outside of Your Payroll
All payments made to employees are taxable and should go through payroll. This means that commissions, bonuses, and even tangible gifts are considered wages or taxable income.
Gift cards are counted the same as cash and need to be considered as taxable wages. If you have properly kept receipts, you may be able to apply for business reimbursement expenses for some of these items.
Incorrectly Classifying Workers
It can be challenging for business owners to understand how to properly classify workers so there is a lot of potential for mistakes. Workers can be classified as employees, statutory employees, statutory non-employees, or independent contractors.
Employers should reference IRS Publication 15-A for the IRS definitions of employment types. IRS Form SS-8 should be used to determine each worker’s status when it comes to tax purposes. The IRS should notify you about which employee classification category you should use for each worker.
While you’re waiting for the IRS to get back to you with their classification decision, be sure you are withholding taxes and reporting wage and tax information. Failing to do so could result in fines come tax-filing time.
Failing to File Forms in a Timely Manner
The federal government requires businesses to report new hires to their applicable state agency. This information must be reported within 10 to 20 business days. Each state then shares this information with the National Directory of New Hires (NDNH).
Companies must also comply with quarterly and year-end tax filing deadlines. If they fail to file the necessary forms before the deadline, they could face penalties, fees, and audits.
The following should be kept in mind:
- Form 941 filings are due on the last day of the month after the end of the quarter
- Year-end deadlines for providing W-2s to your employees, 1099s to contractors, and filing forms 1096 and 1099 with the IRS
- State quarterly filings are due on the last day of the month after the end of the quarter
Failing to Maintain Accurate Employee Records
Companies can easily find themselves in trouble with payroll compliance because of the volume of records they have to keep and the number of requirements to remember. Unintentional non-compliance often happens as a result of simple mistakes in record keeping.
Companies can use checklists as a tool to ensure employees understand what is required when it comes to employee and tax records. Employee documentation is governed by the Fair Labor Standards Act (FLSA), which states:
- Employee payroll records must be kept for at least three years beyond the last entry date
- Any company with 50 or more workers must keep records regarding employee leave as it pertains to the Family and Medical Leave Act (FMLA)
- The IRS requires employee records to be kept for at least four years after the employee leaves
Each state also has its own laws dictated by unemployment agencies that require companies to keep employment records. The time frame for keeping these records is usually between four and seven years.
Inaccurately Tracking Overtime Payments
It’s also important that companies properly track the overtime hours their employees work. Payroll should be processed accurately and in a timely manner to ensure labor regulation compliance.
It’s important to understand whether workers are exempt or non-exempt and that if they are eligible for overtime, they are paid correctly. Overtime income worked is included in taxable wages and taxes must be properly withheld for those hours.
What Happens if You Don’t Pay Your Payroll Taxes?
Are you wondering about the consequences you could face for payroll tax mistakes? The truth is, noncompliance can cost you time and money. You could face fees, fines, and other government penalties resulting in payroll debt.
But these are just the tip of the iceberg. Dealing with correcting your errors, going backward and fixing incorrect paperwork, and filling out more paperwork will cost you time. The amount of labor it will take to correct your mistakes can cost you more than the fines and fees.
Wage issues and payroll issues are far more common than you might think. Even if you appeal the penalties and owed wages you may owe, the appeals and legal actions required will cost you additional time, money, and labor.
In 2019, the State of California issued a press release stating that the Labor Commissioner’s Office cited a construction company a $12 million dollar fine for wage theft that affected over 1,000 workers. Whether mistakes are intentional or accidental, they can cost you big.
Payroll Tax Penalties
The IRS states that employes who fail to follow employment tax laws are subject to both civil and criminal penalties.
The penalty you receive will depend on how much you owe and how late your payment is. The faster you correct your mistake, the less you’ll pay in fees and fines.
For example, if your payment is one to five days late, you’ll face a 2% penalty. However, if your payment is ten or more days late, the penalty jumps to 15%. This figure does not include state penalties that may be assessed against you as well.
Penalties are just one of the ways the IRS will punish you. You’ll also have to pay interest on what you owe. This amount of interest typically charged ranges from 3-6% of the amount you owe.
If the IRS believes you purposely avoided paying your taxes, you could be charged a much more significant penalty and even be subject to prison time. If you don’t pay what you owe, the IRS may file a lien against your property or your assets, including your business.
In addition to the penalties we already mentioned, you could face penalties for filing reports after the deadline.
If you have a good reason for failing to pay your payroll taxes, the IRS might waive your penalty. You’ll have to explain your reason for not paying and justify it as a reasonable cause.
Your tax attorney can help you make your case. For example, if you filed your employment tax return on time but missed a deposit deadline because your depositing schedule changed, your penalty may be waived.
Avoiding Tax Penalties
Mistakes happen to even the most well-intentioned business owners. Business owners are busy people and things can slip through the cracks. Chances are, you don’t want to deal with penalties for missing payroll tax payments.
There are some things you can do to avoid getting into a situation where you owe payroll tax debt.
Withhold, Contribute, and Set Aside
Set yourself up for success by withholding taxes from employee wages every time you run payroll. Be sure to contribute each time as well. If you wait until your tax deposit is due to come up with your tax liability, you won’t have enough money.
Establishing a system that will ensure you withhold and contribute each time you run payroll is the best way to stay on top of these taxes.
Consider Payroll Software
Using payroll software can make this process more automatic. A full-service payroll service will calculate and collect payroll taxes for you. They will even make your tax payments on your behalf.
If you do payroll manually, set up reminders.
Leave Your Tax Savings Alone
If you’re short on cash, it can be tempting to dip into that payroll tax money you set aside. But this is a bad idea. If you borrow from this fund, you may not have enough money to replace it when your deposit is due.
Open a special payroll account to store your collected and contributed taxes. This will help ensure you don’t accidentally tap into these funds for another business expense.
If you foresee yourself being tempted to borrow against this account, establish a cash reserve. Then, if you find yourself short on cash you’ll have an emergency fund to tap into.
Do You Owe Payroll Tax Debt?
If you owe the IRS and are facing payroll tax penalties, you need an experienced tax attorney on your side. If you’ve made a mistake and missed your deposit deadline, what you do next could mean the difference between paying more or getting back on the right track.
We are dedicated to helping business owners understand and resolve their tax liability. Contact us today to get started.